Problems and Questions – Risk Measurement and Hurdle Rates in Practice

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Problems and Questions – Risk Measurement and Hurdle Rates in Practice

Rem.: Use 5.5% as your equity risk premium, for T. Bonds, where none is given, and 8.5% as your short term ERP.

1. In December 1995, Boise Cascade’s stock had a beta of 0.95. The Treasury bill rate at the time was 5.8%, and the Treasury bond rate was 6.4%. a. Estimate the expected return on the stock for a short-term investor in the company. b. Estimate the expected return on the stock for a long-term investor in the company. c. Estimate the cost of equity for the company.

2. Boise Cascade had debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate marginal tax rate was 36%. a. Assuming that the current beta of 0.95 for the stock is a reasonable one, estimate the unlevered beta for the company. b. How much of the risk in the company can be attributed to business risk and how much to financial leverage risk?

3. The following table summarizes the percentage changes in operating income, percentage changes in revenue, and betas for four pharmaceutical firms.

|Firm |% change in revenue |% change in operating income |Beta | |PharmaCorp |27% |25% |1.00 | |SynerCorp |25% |32% |1.15 | |BioMed |23% |36% |1.30 | |Safemed |21% |40% |1.40 |

a. Calculate the degree of operating leverage for each of these firms. b. Use the operating leverage to explain why these firms have different...
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